The US economy is not immune to the Covid-19 pandemic. Increased market volatility, lower stock prices, the reluctance of shareholders to endorse short-term goals of shareholder activists and higher scrutiny from advisory firms have created an environment that is expected to lead to an increase in hostile takeovers yet again.
In advance of the potential resurgence of unsolicited takeover attempts, boards should consider the defense mechanisms available to them and revisit their fiduciary duties.
Poison pills (or shareholder rights plans) are versatile defense mechanisms. They can be used to protect companies’ net operating losses as well as defend companies against corporate takeovers and shareholder activism. Under the new circumstances, a board should consider having a poison pill on the shelf. In addition, companies in some states may have the protection of statutory defense mechanisms.
POISON PILLS AND FIDUCIARY DUTIES UNDER DELAWARE AND MINNESOTA LAW
Keeping a poison pill on the shelf means drafting its documentation as a preparatory measure. The pill itself is adopted, or ‘taken down’, only when a specific threat arises. Preparing the necessary paperwork in advance allows the board to act more quickly in response to a threat, when time is often of the essence.
The fiduciary duties described below apply when a board considers whether it is appropriate to adopt a poison pill in response to a specific threat.
Delaware
- Standard: Under Delaware law, the board’s power to act derives from its fundamental duty and obligation to protect the corporate enterprise, which includes stockholders, from harm reasonably perceived, irrespective of its source. When the board addresses a pending takeover bid, it has an obligation to determine whether the offer is in the best interests of the corporation and its stockholders. For a defensive measure to fall within the protection of the business judgement rule, however, the defensive measure must be reasonable in relation to the threat posed.
- Application: This entails an analysis by the directors of the nature of the takeover bid and its effect on the corporate enterprise. Examples of such concerns may include inadequacy of the price offered, nature and timing of the offer, questions of illegality, the risk of non-consummation and the quality of securities being offered in the exchange. Directors must show they had reasonable grounds for believing the danger to corporate policy and effectiveness existed because of the threat posed.
Minnesota
- Standard: A poison pill adopted by a Minnesota corporation will be upheld if: (i) the board has satisfied its fiduciary duties in adopting the poison pill by acting in good faith, in a manner reasonably believed to be in the best interests of the corporation; and (ii) with the care an ordinarily prudent person in a like position would act under similar circumstances, and the plan does not violate the statutory provisions of the Minnesota Business Corporation Act (MBCA).
- Application: The court in the only Minnesota published decision, Gelco Corp, addressed both standards in determining not to preliminarily enjoin the adoption of a poison pill. With respect to the first part of the test, the court concluded that the directors have the initial burden of showing they had reasonable grounds to believe a danger to corporate policy and effectiveness existed – that is, by showing good faith and reasonable investigation – and the defensive measures adopted were reasonable in relation to the threat shown. The court also indicated that the burden can be satisfied even if the poison pill is not adopted in response to a specific threat but instead to deter possible future advances. As a practice pointer, the court also clearly gave weight to the fact that the defensive measures were adopted by independent directors.
POISON PILLS AND PROXY ADVISORY FIRMS
Even after satisfying their fiduciary duties, boards should consider an additional level of scrutiny: proxy advisory firms. ISS and Glass Lewis both support the adoption of poison pills under very limited circumstances. In particular, those firms have indicated that poison pills must have a limited term – with a duration of less than one year – and be properly justified.
In its most recent guidance published on April 8, 2020, ISS recognized that ‘[a] severe stock price decline as a result of the Covid-19 pandemic is likely to be considered a valid justification in most cases for adopting a pill of less than one year in duration.’
However, ISS still expects boards to provide detailed explanations regarding their choice of duration and any decisions to delay putting the plans to a shareholder vote beyond that period. ISS will continue to closely evaluate the triggers for such plans considering the rationale provided by boards and the length of the plan adopted, among other factors.
STATUTORY PROTECTIONS
Statutory protections vary by state and can be helpful defensive mechanisms provided that the company has not opted out of them.
Control share acquisition statutes
Some states, including Minnesota, have control share acquisition statutes. The Control Share Acquisition Act, Section 302A.671 of the MBCA, applies when a person becomes a beneficial owner of 20 percent or more of the voting power of the shares of an ‘issuing public corporation’.
As a result of such an acquisition, only the shares below the 20 percent threshold will have voting power unless such voting rights are restored following the voting process under the statute. Even after such approval, however, the statute continues to protect the company and its shareholders.
In particular, additional reinstatement of voting rights will be required if such person crosses the 33 1/3 percent ownership threshold and a similar shareholder vote is generally required to permit the acquiring person to exercise a majority of the voting power following the acquisition of shares otherwise entitled to a majority of such voting power. Delaware does not have a similar statute.
Business combination acts
Both Minnesota and Delaware have a business combination act. Both statutes provide that certain ‘interested shareholders/stockholders’ generally cannot enter into a merger or some other transactions with a publicly held corporation for a certain period of time after becoming an ‘interested shareholder/stockholder’ unless such transaction is preapproved in accordance with the statute.
Delaware
- Interested stockholder: Subject to certain exceptions, an ‘interested stockholder’ includes any person who is: (i) the owner of 15 percent or more of the outstanding voting stock; or (ii) an affiliate or associate of the corporation that, at any time within the three-year period before the transaction in question, was the owner of 15 percent or more of the outstanding voting stock, and the affiliates and associates of such a person.
- Moratorium: The moratorium on mergers and some other transactions applies for three years after a stockholder becomes an interested stockholder.
- Exceptions: There are exceptions to the moratorium if: (i) prior to the transaction in question, the board of directors approved either the transaction in question or the acquisition by the stockholder that resulted in the stockholder becoming an interested stockholder; (ii) the stockholder after the transaction in which it becomes an interested stockholder owns at least 85 percent of the outstanding voting stock that is not owned by persons who are both directors and officers or certain employee stock plans; or (iii) if the transaction in question is approved by both the board of directors and at least two thirds of the voting stock not owned by the interested stockholder.
Minnesota
- Interested shareholder: Subject to certain exceptions, an interested shareholder includes: (i) the beneficial owner who owns directly or indirectly 10 percent or more of the voting power of the outstanding shares entitled to vote; or (ii) an affiliate or associate of the corporation that, at any time within the four-year period before the transaction in question, was the beneficial owner, directly or indirectly, of 10 percent or more of the voting power of the then outstanding shares entitled to vote.
- Moratorium: The moratorium on mergers and some other transactions applies for four years following the shareholder becoming an interested shareholder.
- Exception: The four-year moratorium can be avoided if, before the shareholder becomes an interested shareholder, the transaction in question or the acquisition of shares by the interested shareholder is approved by a committee composed of one or more disinterested directors who have not been officers or employees of the corporation or a related organization during the preceding five years.
TIME TO RE-EVALUATE
It is a perfect time for companies to re-evaluate their activism response plans and protections and address any loopholes. All decisions must be made on a case-by-case basis upon considering the governing law of the corporation, any available statutory protections and the particular circumstances and constituencies of the corporation. As in many circumstances, there is no one-size-fits-all solution, but having a poison pill ready to go will only increase the board’s nimbleness if a threat arises.
Vilena Nicolet is a corporate attorney with Faegre Drinker Biddle & Reath in Minneapolis
